The Supreme Court has set January 17 as the date for the oral argument in Home Concrete, the case in which it will decide the “Intermountain” issues concerning the applicability of the six-year statute of limitations to overstatements of basis, on which we have reported extensively many times before. (Seehere and here for a sample.) In the meantime, the briefing has commenced with the filing of the government’s opening brief (linked below).

The brief covers what is mostly familiar ground at this point, but it does further develop some of the arguments that have emerged in the course of the court of appeals litigation, with particular reliance on the D.C. Circuit’s decision in Intermountain. The government divides its argument into three sections. The first analyzes the statutory text, structure, and purpose, emphasizing a broad definition of the word “omission” and arguing that its position is supported by other subsections within section 6501(e). Second, the government argues for deference to the final regulations. Finally, the third section argues that the Supreme Court’s Colony decision is not controlling.

With respect to the administrative deference point that is of the broadest significance in this case, the government not surprisingly offers up arguments that will enable the Court to rule in its favor without exploring the outer limits of the power that the Court’s recent precedents arguably confer on the Treasury Department. But the government does not shirk from pushing those limits in case its other arguments are unpersuasive.

For example, although the government argues that the Colony decision is inapplicable because it involved a 1939 Code provision that has since changed in some ways, the government maintains that it should still prevail even if no changes had been made to the statute in the 1954 Code. “Under Brand X,” the government states, “the new Treasury Department regulation would be entitled to Chevron deference even if that rule construed precisely the same statutory provision that was before the Court in Colony.” Thus, the government is not bashful about claiming an extraordinary amount of power for the Treasury Department. Congress can pass a law establishing a particular rule, and the Supreme Court can construe that law, but the Treasury Department can turn it all upside down as long as the Court did not declare the statutory language unambiguous.

The government’s brief also addresses the additional objection that the regulations operate retroactively. The government argues that they are not truly retroactive, because they supposedly “clarified rather than changed existing law” (notwithstanding Colony and two court of appeals decisions that were unquestionably on point) and addressed “procedures,” rather than the legality of the conduct. In the end, however, the government maintains that “the rule would be valid even if it had retroactive effect.” Thus, the government fully embraces an expansion of the Treasury Department’s power beyond that recognized in Mayo — arguing that an agency not only has the power to promulgate rules that overturn settled judicial precedents, but also has the power to apply those new rules to prior years. Given that even Congress is usually constrained in adopting retroactive legislation, it will be interesting to see if the Court balks at conferring this kind of power on unelected officials.

On November 16, the Tenth Circuit heard oral argument in the Anschutz case, involving the taxpayers’ appeal from the Tax Court’s decision to collapse two transactions involving the use of prepaid variable forward contracts (“PVFCs”) and concurrent share lending agreements (“SLAs”), and treat them as a taxable sale of stock. A fuller description of the case and the parties’ briefs can be found in our prior reports here and here.

The panel hearing oral argument was Chief Judge Briscoe (a Clinton appointee and former Kansas state court judge and Assistant U.S. Attorney), Senior Judge McKay (a Carter appointee who was previously in private practice), and Judge O’Brien (a Bush II appointee who served for many years as a Wyoming state judge).

There is no specific date by which the court must decide the case, but a decision is most likely in the spring of 2012.

The NPR case (involving penalty application and TEFRA issues in the context of a Son of BOSS transaction: see latest substantive discussion here) has been calendared for argument in New Orleans on December 7th in the East Courtroom.

In what appears may be the first in a series of cases on the endorsement income of non-resident aliens, the Tax Court was tasked with characterizing and sourcing the endorsement income for golfer Retief Goosen. The court’s decision may impact how other athletes and entertainers structure their endorsement deals and indicates how taxpayers should expect the IRS to source royalty income in similar cases.

Goosen, a native South African who is a U.K. resident, is subject to U.S. tax because playing professional golf in the U.S. amounts to engaging in a U.S. trade or business. He had endorsement agreements with Acushnet (which makes Titleist golf balls), TaylorMade, and Izod to use or wear their products while playing golf (these are the “on-course” endorsements). He also had endorsement agreements with Rolex, Upper Deck, and Electronic Arts (the “off-course” endorsements).

There were three main issues before the Tax Court:

(1) Was Goosen’s on-course endorsement income personal services income or royalty income or some combination of the two? (The parties agreed that all of the off-course endorsement income was royalty income.) The personal services income of nonresident aliens is subject to regular U.S. tax rates; they typically owe less U.S. tax on royalty income under tax treaties.

(2) What portion of Goosen’s royalty income was U.S.-source income? Under section 872, the gross income of nonresidents includes U.S.-source income.

(3) What portion, if any, of that U.S.-source royalty income was effectively connected to a U.S. trade or business? While U.S.-source royalties are generally subject to a flat 30% withholding tax, if royalties are effectively connected to a U.S. trade or business, they are subject to the graduated rates that apply to U.S. residents.

On the first issue, Goosen argued that the on-course endorsements were paid for the use of his name and likeness, which is classic royalty income. The IRS argued that because the on-course endorsement agreements required Goosen to make personal appearances and to play in a minimum number of golf tournaments (all while using Titleist balls and TaylorMade clubs and wearing Izod), the on-course endorsements were paid for personal services. The court split the difference, deciding that the sponsors paid for both the use of Goosen’s image and likeness and for personal services.

On the one hand, the court found that the sponsors were paying for more than just Goosen’s golfing—that the sponsors wanted to be associated with Goosen’s image. The court cited the morals clause in a couple of Goosen’s endorsement agreements as evidence that the sponsorship was about more than just golfing. (This morals-clause discussion enabled the court—and, conveniently, this blog entry—to meet the requirement that anything written about golf must mention Tiger Woods.)

The court also cited expert testimony from Jim Baugh (formerly of Wilson Sporting Goods) for the proposition that image is sometimes more important than performance. Baugh testified that while Goosen has won more and consistently been ranked higher than golfer Sergio Garcia, the two have effectively identical endorsement agreements with TaylorMade. Baugh attributed this to Garcia’s “flash, looks and maverick personality.” This is notable testimony because Garcia has his own Tax Court case pending, which is set for trial in Miami in March 2012. By detailing this testimony, the court gifts Garcia with a tailor-made argument that, relative to Goosen, a greater portion of Garcia’s TaylorMade endorsement income is royalty income.

On the other hand, the court held that the endorsement income could not be solely attributable to Goosen’s image. After all, the on-course endorsements required Goosen to make personal appearances and to play in a specified number of tournaments, all while wearing or using the sponsors’ products. Acknowledging that precision in allocating between royalty and personal service income was unattainable, the court settled on a straightforward 50-50 split.

As for the second issue, the court was left to decide what portion of Goosen’s royalty income was U.S.-source income. Generally, the source of royalty income from an intangible is where the property (in this case, Goosen’s image) is used. With respect to the Upper Deck and EA endorsements, the court looked to the relative U.S.-to-worldwide sales percentages of Upper Deck’s golf cards (92% in the U.S.) and EA’s video games (70% in the U.S.) and then sourced Goosen’s royalty income accordingly. For the three on-course endorsements and the Rolex endorsement, the court determined that while Goosen was marketed worldwide, the U.S. constitutes about half of that worldwide golf market. The court therefore treated half of the income from those four endorsements as U.S.-source income.

Finally, the court had to decide whether any of that U.S.-source income was effectively connected to a U.S. trade or business. The court held that only the on-course endorsement royalty income was effectively connected to a U.S. trade or business. The court found that since the off-course endorsements didn’t require Goosen to play golf tournaments or to be physically present in the U.S., that royalty income was not effectively connected to the U.S.

The aspect of the decision that seems to have scared some practitioners (other than the existence of a worldwide market for collectible golf cards, which maybe scares only this practitioner) was how the court sourced royalty income according to the U.S.-to-worldwide sales percentages. The fear is that the IRS will simply apply those percentages in every case, and taxpayers will have no room to negotiate a more favorable allocation.

We’ll keep an eye on where this case heads and will post updates on the Sergio Garcia case.

About Miller & Chevalier’s Tax Appellate Blog

Miller & Chevalier was founded in 1920 as the first federal tax practice in the United States. For nearly 95 years, the firm has successfully represented the most sophisticated corporate clients in all facets of federal income taxation. Miller & Chevalier’s Tax department serves clients headquartered throughout the U.S. and around the world and, over the past several years, has represented approximately 30 percent of the Fortune 100 and more than 20 percent of the Global 100. Our clients come to us to solve the thorniest of tax issues, and we have litigated many of the most significant tax cases on record.

The Tax Appellate Blog is intended to be a resource for information on important tax cases under consideration in the appellate courts. It will feature insightful commentary on the issues and provide a dedicated site for following the progress of these cases.

Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.